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Imagine a world where your future self has all the time you need to travel, pursue hobbies, or spend time with friends and family without worrying about finances. Sounds like a dream? Well, a 401(k) plan is a tool that can help your dream become a reality.

Simply put, a 401(k) is an employer-sponsored retirement savings plan that allows you to invest a portion of each paycheck.

There are many benefits of having a 401(k). By the end of this guide, you’ll see just how accessible and beneficial a 401(k) can be.

9 pros of a 401(k) explained

A 401(k) is more than just a savings account – it offers a variety of perks that can help you turbo-charge your retirement savings. Let’s explore the advantages of 401(k) plans when planning for retirement.

1. Tax advantages

First, a 401(k) comes with serious tax perks. You make contributions on a pre-tax basis, which means the contributions reduce your taxable income, and you’ll owe less income taxes for the year.¹

Plus, the money you invest grows tax-deferred. This means you won’t owe any income tax on the profits you make from your investments until you start withdrawing the money, which typically happens after you retire.

2. Matching contributions from your work

Many employers offer to match your 401(k) contributions up to a certain percentage. For example, your employer might match 50% of what you put into the account, up to a maximum of 6% of your salary.

This is essentially free money, so try to contribute at least enough to qualify for the full match.

3. Generous contribution limits

In 2024, you can contribute up to $23,000 to your 401(k), with an additional catch-up contribution of $7,500 if you’re 50 or older.²

This ceiling is significantly higher than that of an Individual Retirement Account (IRA), which has a maximum contribution limit of $7,000 in 2024 ($8,000 if you’re 50 or older).

This higher contribution limit allows you to save faster and potentially retire sooner than you would by saving with an IRA alone.

4. Option for taking a loan

Need money for an emergency? Your 401(k) might let you borrow from your future self without a traditional loan credit check.

The maximum amount you can borrow from your 401(k) plan is 50% of your vested account balance or $50,000, whichever is less.³ You generally need to repay the loan with interest within five years. However, the interest you pay goes back into your own 401(k) account.

5. Penalty-free access to funds at an earlier age

Typically, if you withdraw money from your 401(k) before the age of 59.5, you’ll pay a 10% early withdrawal penalty. However, you can access your 401(k) funds as early as age 55 without penalty under certain conditions.

This loophole is known as the “Rule of 55.” If you turn 55 (or older) in the year you lose or leave your job, you can start taking distributions from your 401(k) without paying the early withdrawal penalty.⁴ However, you must still pay taxes on those withdrawals.

6. Student loan payment matching

A newer feature of 401(k)s allows employers to match your student loan payments with contributions to your 401(k).⁵

This is new for 2024, but it’s likely to be popular among young employees who feel like they need to choose between saving for retirement and paying off their student loans.

7. Asset protection from creditors

In most cases, your 401(k) is safe from creditors, even if you declare bankruptcy or face a lawsuit.⁶

This is especially important for business owners or employees in litigation-prone fields like health care or construction.

8. Exemption from the IRA aggregation rule

The “IRA aggregation rule” essentially states that if you have multiple IRAs, they’re treated as a single account when calculating taxes on a Roth IRA conversion or required minimum distributions (RMDs).⁷

This rule doesn’t apply to 401(k) ‘s, meaning you can take advantage of some tax strategies with a 401(k) that you can’t with an IRA.

For example, if your 401(k) plan at work allows it, you can roll the pre-tax balances from your IRAs into your 401(k), then you can convert the remaining balance into a Roth IRA without generating any tax bill on the conversion.

Roth conversions can be tricky, so it’s helpful to discuss this strategy with a tax professional.

9. Emergency savings fund option

Some 401(k) plans offer a hardship withdrawal option, which allows you to withdraw money from your 401(k) account to deal with an immediate and substantial financial need, like paying for medical expenses, funeral costs, education expenses, or home repairs.⁸

While these distributions are taxable income, you may be able to avoid the 10% early withdrawal penalty. You also don’t have to worry about paying the hardship withdrawal back.

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Considerations of a 401(k) explained

Despite the many benefits of 401(k) plans, they come with a few caveats. Let’s look at the considerations of committing to a 401(k) plan to help you make the most informed decisions for your financial future.

1. Limited options for brokers and investments

When you opt for a 401(k), your investment options are selected by your employer’s plan. You typically have to choose from a list of target-date funds, mutual funds, and exchange-traded funds (ETFs).

While these options are generally diversified, they may not include the specific investments you’re eyeing, limiting your ability to tailor your portfolio to your preferences.

2. Age requirements

While there’s no federally mandated minimum age for participating in a 401(k) plan, state laws and age of majority rules may prevent anyone under 18 from contributing to a 401(k).9

You may have to wait until you turn 18 (or 21 in some states) to participate in your employer’s 401(k).

3. Mandatory withdrawals

Once you reach age 72 (73 if you turn 72 after December 31, 2022), you must start taking withdrawals from your 401(k), whether you need the money or not.10 This can be a bit of a double-edged sword, especially if you don’t need the money for your daily living expenses and prefer to let them continue growing tax-deferred.

While these considerations might seem like drawbacks, they’re part of the 401(k) ‘s design to ensure it serves its purpose as a retirement savings vehicle. Understanding these limitations allows you to plan more effectively, ensuring that when it’s time to retire, you can do so with the financial security you’ve worked hard to build.

401(k): One way to maximize your savings

From 401(k) tax breaks and employer matching contributions to the flexibility and protection it offers, a 401(k) is more than just a savings plan – it’s a resource to help you achieve a secure and enjoyable retirement.

Remember, every step toward saving and investing is a step toward a more secure and fulfilling retirement.

If you change jobs frequently, you may have retirement savings in a previous plan. Learn how to find your old 401(k) accounts and what to do once you track them down.

FAQs about 401(k)s

Now that you know the pros and cons of 401(k) plans, here are answers to a few frequently asked questions about 401(k)s.

Are 401(k)s worth it anymore?

Absolutely! Despite the changing economic landscape, 401(k)s remain a cornerstone of retirement planning for several reasons. They offer tax advantages, employer matching (free money!), and the potential for your investments to grow tax-deferred.

While investment returns can fluctuate, the tax benefits and compound growth over time make 401(k)s a valuable tool for building your retirement nest egg.

Does a 401(k) save you money?

Yes, in more ways than one. First, your 401(k) contributions are made pre-tax, reducing your taxable income for the year. This means you could owe less taxes now, keeping more money in your pocket.

Second, tax-deferred growth means you don’t pay taxes on your investment gains until you withdraw the money in retirement, potentially saving you a significant amount in taxes over the long haul. Plus, if your workplace offers an employer match, those additional savings can significantly boost your retirement fund.

What are the advantages of rolling over a 401(k) to an IRA?

Rolling over a 401(k) to an IRA can be a smart move for several reasons. IRAs often offer a wider range of investment options than 401(k) plans, giving you more control over your investment strategy.

IRAs can also provide more flexibility in terms of withdrawal options and tax planning strategies. For example, with a Roth IRA, you pay taxes on contributions upfront but can withdraw your money tax-free in retirement.

Finally, consolidating multiple 401(k) accounts from past employers into a single IRA can simplify your finances, making it easier to manage your retirement savings.

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¹ Information from IRS's "401(k) Plan Overview" as of April 9, 2024: https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-401k-plan-overview

² Information from IRS’s “401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000” as of March 27, 2024: https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000

³ Information from IRS’s “Retirement Topics – Plan Loans” as of March 27, 2024: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-loans

⁴ Information from IRS’s “Retirement topics: Exceptions to tax on early distributions” as of March 27, 2024: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-on-early-distributions

⁵ Information from International Foundation of Employee Benefit Plans’ “Matching Contributions for Qualified Student Loan Payments Under Secure Act 2.0” as of March 27, 2024: https://blog.ifebp.org/matching-contributions-for-qualified-student-loan-payments-under-secure-act-2-0/

⁶ Information from Equifax's "Can Creditors Go After My Retirement Accounts?" as of April 9, 2024: https://www.equifax.com/personal/education/life-stages/articles/-/learn/protect-retirement-account-from-creditors/

⁷ Information from NTSA's "Should Your Clients Hold Multiple IRAs?" as of April 9, 2024: https://www.ntsa-net.org/should-your-clients-hold-multiple-iras

⁸ Information from IRS’s “Retirement Topics – Hardship Distributions” as of March 27, 2024: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions

⁹ Information from Cornell Law School's "Age of Majority" as of April 9, 2024: https://www.law.cornell.edu/wex/age_of_majority

¹⁰ Information from IRS’s “Retirement plan and IRA Required Minimum Distributions FAQs” as of March 27, 2024: https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs

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